How Does a Recession Effect the Stock Market?

Last week economists were predicting that there is an 80 per cent chance Australia could fall into a recession. This normally evokes fear in investors, as they become more cautious and uncertain about the economy. A recession is generally defined as a period of economic decline, which typically involves lower economic activity, rising unemployment, and falling consumer and business confidence. So how will a recession effect the stock market?

Is a recession positive for the stock market?

It’s reasonable to assume that in recessionary times companies may experience a decline in revenue and profitability, and as such investors may become hesitant to buy stocks. Investors also tend to assume that stock prices will fall as demand for shares decreases and, consequently refrain from buying shares. However, in my experience investors are reluctant to sell their shares, especially if they’re in a loss. So, does the stock market fall during a recession or is this a period of opportunity for those who are prepared.

We know in recessionary times interest rates tend to fall away, which can make stocks more attractive because they can offer potentially higher returns than other investments. Investors also want to buy shares in companies that will grow, which is why it’s wise to purchase during times when the economy is slow in preparation for a growing economy and increased profits.

If we look at the 1929 crash and subsequent depression, the Australian stock market halved in value and fell into a low in 1931 before rising over 300 per cent. In the mid-1970’s, Australia experienced another recession and, once again, the market rose ten-fold into the 1987 highs. In the early 1990’s, Australia experienced the recession Paul Keating said, ‘we had to have’ and just like the previous recessions, the market rose strongly into the highs of 2002.

So, my advice to investors is regardless of whether a recession occurs, look at the next year as one of opportunity.

What were the best and worst performing sectors last week?

The best performing sectors included Information Technology up 2.98 per cent followed by Healthcare up 1.45 per cent and Energy up 1.43 per cent. The worst performing sectors included Utilities down 1.13 per cent followed by Materials down 0.49 per cent and Consumer Staples down 0.47 per cent.

The best performing stocks in the ASX top 100 included Allkem up 21.70 per cent after it agreed to merge with the New York Stock Exchange listed lithium company Livent. This was followed by Lynas Rare Earths up 12.16 per cent and Pilbara Minerals up 8.64 per cent. The worst performing stocks included Block down 7.54 per cent followed by Newcrest Mining down 5.20 per cent and QBE down 4.82per cent.

What's next for the Australian stock market?

Following a strong rise last Monday, the All Ordinaries Index drifted down and sideways over the remainder of the week in what is considered a very normal manner. It now appears as though the market has found support around my target zone of 7,330 points and is now starting to rise again, but before you get too excited, we still need to confirm this.

The market closed the week up 0.54 per cent, which in anyone's opinion is not a sign of strength. If everything unfolds as I suspect in this coming week, the index should rise to close higher for the week. If this is correct, we will see it trade higher over the next one to two months to above 7,800 points.

We still need to remain patient, as we need to see the market move up in a sustained rise to above 7,600 points to confirm the bull market has returned. There is plenty of time to take advantage of opportunities that will unfold, so I caution investors to resist the temptation of investing because of FOMO because jumping in too early will increase your risk, which may result in losses.

 For now good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the bestselling and award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.